August Portfolio Update | 2020

Thoughts on the Market: August Edition

 

The Stock Market is Not the Economy.

It’s becoming increasingly apparent that the COVID-low in the market occurred in March. That statement may seem blindingly obvious with the S&P500 reaching a new all-time high on September 2, but after a continuous bombardment of headlines like “economy sucks, stocks overvalued”, it can be tough to see the forest for the trees.

Financial markets are a lot more forward looking than often credited but this fact is obscured when short-term and herd-like cognitive factors push markets to extremes. We would argue the March 23 low was the second-best buying opportunity of the past decade, surpassed only by the December 2018 sell off. And while we don’t fault Warren Buffett for selling his entire airline stake at the bottom (we would be very nervous owning airlines as well), we added Starbucks, an extremely profitable and world-renowned brand, to our portfolio at a price that was 40% below its normalized value. We acknowledge there were risks and that we did not foresee the swiftness of the recovery, but we believed that the long-term earnings impairment of Starbucks was not in the 40% range as we observed 15-minute line-ups at its drive-thru locations.

Fast forward 6 months from late February and markets are back to where they started. The Atlanta Federal Reserve’s GDPNow forecast (Figure 1), which looks at real-time GDP indicators, continues to climb for Q3 and is approaching 30% quarter over quarter growth. With the economic recovery in full speed, picking stocks will likely become more and more difficult. There are a number of key questions we ask ourselves. Will the tech exuberance persist or was the COVID-pull forward a one-time demand shock that has fully played out? Do physical asset sectors (airlines, autos, malls, industrials) recover to previous highs or is the impairment long term? What effect does negative real rates have on the equity markets? Will financials recover without an interest rate recovery?

Figure 1: Atlanta Fed Q3 GDPNow real-time estimate

We believe our COVID-19 Investing Framework is helpful. Broadly, we view equities as falling under four categories as outlined in Figure 2. The COVID Beneficiaries (mostly technology and home improvement companies) have mostly surged to new highs and are priced for ongoing growth. We believe the best value lies in what we refer to as the Transient and Short-Term Impact groups, which should see sales and earnings recover with higher economic activity. There was undoubtedly some bubbly activity in the technology space but as outlined in our August Report, we don’t believe we are in a technology bubble and are comfortable holding our names for the mid-term.

Figure 2: MWG COVID Investing Framework

 

As we look forward to 2021, signs of normalization should appear. By investing in companies that can adjust business models and grow in a post-COVID world, we believe we can continue to deliver strong returns.

GLOBAL EQUITY GROWTH FUND

The MWG Global Equity Growth Fund rose 6.1% in August, bringing its year-to-date return to 5.1%. Over the past twelve months, the portfolio has returned 15.6%. The top performers in August were Royal Caribbean Group (+37%), Stelco (+22%) and Mastercard (+12.9%). Tyler Technologies (-6.0%), Twilio (-5.4%) and Aon (-5.2%) were the laggards during the month.

We made no additions or deletions to our holdings. However, we continued to add to our most recent purchases, Tyler Technologies and Aon Inc., using weakness in both to build our positions. We also trimmed our Starbucks holding as the shares approached our target price and we saw better opportunities in other portfolio names. Amazon’s weighting rose to 6% on market appreciation and we decided against re-balancing back to its previous 5.5% weighting (the company’s cash flow growth is unrivalled).

Conversely, we reduced our target weighting in Raytheon as it has outsized profitability to engine maintenance replacement parts for the older part of the commercial aircraft fleet. As air traffic recovers, we would expect airlines to re-employ their newer aircraft initially.

INCOME GROWTH FUND

The MWG Income Growth Fund rose 3.4% in August, bringing its year-to-date return to -23.8%. Over the past twelve months, the portfolio has returned -15.7%. The top performers in August were Corus Entertainment (+33%), Exchange Income (+20%) and Chorus Aviation (+14%). Cominar REIT (-11%), Alaris (-10%) and BP (-6%) were the laggards during the month.

We added Restaurant Brands International to the portfolio with a 2% position. Restaurant Brands is a franchise owner of the Tim Hortons, Burger King and Popeye’s Brands. Like most restaurants, the pandemic has significantly affected short-term profitability with store closure and lower sales. However, we believe the company has a strong position in both Tim’s and Burger King, while Popeye’s provides a growing banner for new units. The company is also strongly positioned with a high number of drive-thru locations. We expect sales to recover through 2021 with additional growth from new units, higher efficiency (mainly digital initiatives) and new products.

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